The loss leaves Real second in the table with 78 points, seven behind leaders Barcelona, who have one game in hand over Los Merengues.
Valencia's win enforces their status in fourth spot with 60 points as Los Ches are in contention for a top-four place to secure UEFA Champions League football next season.
Attacking midfielder Juan Mata opened the score line for Valencia on 28 minutes after finishing a lovely move initiated by David Villa and David Silva.
Silva himself added his team's second two minutes later before experienced skipper Ruben Baraja sealed the home side's win with a 68th minute strike.
The defeat means that Real have conceded 9 league goals in two weeks, after the capital club's 6-2 battering at the hands of Barcelona at Santiago Bernabeu on May 3rd.